If you had invested £1 in the FTSE All Share Index a decade ago you would currently have 64p of profit, including dividends. But that same £1 invested in the S&P500 - the most representative index of American stocks - over the same time would have made a profit of £3.38p (over 5 times your money) (See Fig 1. FTSE All Share Vs. S&P500 Total Return).
Fig 1: FTSE All Share Vs. S&P500 Total Return (in £ terms)
Whilst UK investors may rue missing the bus, this feeling is widely shared amongst non-US domestic investors everywhere, with returns from American equities being the exception rather than the rule. What is the US getting right that everyone else is getting wrong?
The UK government seems to believe that our listing requirements are too strict and that these should be relaxed, to avoid turning the London Stock Exchange into the “safest graveyard”. But lower standards of corporate governance would allow dodgy companies to abuse the capital of UK minority shareholders more easily. Short sellers will be licking their lips.
Neither do plans to force UK investors to allocate to domestic assets impress. The liberalization of capital markets has allowed UK investors to sell domestic shares to foreigners and so far, get the better of that bargain. If UK investors are forced to invest domestically it would be a market distortion that allows foreign capital to exit at falsely higher prices.
There is no evidence to suggest that the UK stock market is any less efficient than any other in undervaluing investment opportunities. Although ARM Holdings has recently enjoyed a stellar US listing (albeit with a tiny float) - becoming only the 5th UK company with a £100 billion plus valuation - US listings for UK companies such as Farfetch, Polestar, IHS, Babylon and Vertical Aerospace have been an unmitigated disaster.
Share prices – believe it or not – tend to follow or even anticipate shareholder profits. Whereas the earnings per share of the FTSE All Share Index have grown by 47% (in £ terms) over the last decade, those of the S&P500 have risen by a whopping 156% (in £ terms) (See Fig 2: FTSE All Share Vs. S&P500 FY12 EPS). This alone explains the divergence in investment returns between the UK and US.
Fig 2: FTSE All Share Vs. S&P500 FY12 EPS (in £ terms)
“The Magnificent 7” vs. “The Unfortunate 5”
Recently there has been a lot of attention on the performance of the so-called “Magnificent 7” stocks in the US: Microsoft, Apple, Alphabet, Amazon, Nvidia, Meta and Tesla. These companies together now have a market value of $13trillion, which is one quarter of the US market, and roughly the same size as all European stock markets including the UK combined.
It might be easy to dismiss the share price performance of “The Magnificent 7” as an “investment bubble” until we consider that they are forecast to make over a combined $400bn of net profit this year (up from $85bn a decade ago) (See Fig 3: “The Magnificent 7” Net Profit since 2014 (in $ terms)).
Fig 3: “The Magnificent 7” Net Profit since 2014 (in $ terms)
The average share price return from “The Magnificent 7” of 2686% (27x) (in $ terms) over the same period is predominantly explained by the average earnings per share growth (they’ve also bought back a lot of shares) of 1769% (18x) since 2014 (See Fig 4: “The Magnificent 7”: Price vs. EPS (in $ terms)).
Fig 4: “The Magnificent 7”: Price vs. EPS since 2014 (in $ terms)
Contrast “The Magnificent 7” with the five biggest FTSE companies that also constitute one quarter of our UK stock market: Shell, Astra Zeneca, HSBC, Unilever and BP.
Together these companies have grown their net profits (in $ terms) by only 20% over a decade (See Fig 5: “The Unfortunate 5” Net Profit since 2014 (in $ terms)) (earnings per share by an average of 34%) explaining the more modest average 65% (in $ terms) increase in share price since 2014 (See Fig 6: “The Unfortunate 5”: Price vs. EPS since 2014 (in $ terms)). Whilst the US has “The Magnificent 7”, it seems that the UK has only “The Unfortunate 5”.
Fig 5: “The Unfortunate 5” Net Profit since 2014 (in $ terms)
Fig 6: “The Unfortunate 5”: Price vs. EPS since 2014 (in $ terms)
Some will of course argue that America simply has a bigger technology industry than the UK but there is nothing pre-ordained about this. “The Magnificent 7” companies were on average founded just 30 years ago (1994) with Tesla (2003) and Meta (2004) founded this century (See Fig 7: Tenure of “The Magnificent 7” and “The Unfortunate 5”).
Fig 7: Tenure of “The Magnificent 7” and “The Unfortunate 5”.
By contrast, the average age of “The Unfortunate 5” is now 115 years (circa 1909). What does this say about the environment for private enterprise in the UK?
Across many different industries American companies dominate because they have been generally laser focused on profit. By contrast, Unilever fought a marketing campaign to prove the moral worth of Hellman’s Mayonnaise, whilst our Oil & Gas companies have long since become cowed by climate change activists, deciding presumably as an act of penitence to diversify into low economic value alternative energy projects, with disastrous consequences for shareholder returns.
Not enough focus on profit
The real reason the Footsie is failing is that UK Plc, along with the rest of Western Europe, has turned its back on capitalism.
The basic fiduciary duty of company management to maximize profit for shareholders has been replaced by the need to appease all stakeholders.
Like many bad ideas, Environmental, Social and Governance (ESG) regulation originated in Brussels, with the onerous imposition of reporting requirements on publicly traded companies (as well as investment funds) on their compliance with a “low carbon sustainable economy”1 in addition to eliminating historic discrimination and incorporating any other trendy issue of the day. How management ever gets round to thinking about generating a profit is not clear.
Don’t be fooled by the inclusion of “Governance” in ESG, since this is not inclusive of traditional concepts such as whether management are stealing from shareholders or cooking the books. It focuses instead on adherence to the woke political agenda. Rather embarrassingly nearly every high-profile corporate blow-up of recent times has occurred with the rogue company having the highest ESG ratings.
Accountability to shareholders has been displaced by a need to manage different interest groups. Consequently, the Boards of our PLC’s end up being accountable to no one, able to indulge their own pet social and environmental projects, paid for with someone else’s money.
ESG has spawned a bull market in mindless bureaucracy: small companies won’t go public due to the reporting requirements, whilst profitable old economy companies will go private. It hasn’t yet occurred to the UK government not to follow the EU down the same disastrous path.
Our government has recently shown a revived appetite to compete with companies and investors in allocating capital. Although the historic track record of state industrial policy in picking winners is patchy, the record of loser companies – requiring endless taxpayer support - picking government is exemplary.
The logical end game of ESG is even worse: involving not just government but all public capital being allocated – not primarily for profit – but according to the political values of organizations which are not democratically accountable. Isn’t this communism?
As Milton Friedman2 pointed out, the responsibility of business is to make as much money as possible within the rules of society. Those rules should be set by a democratic parliament, not unaccountable, unproductive, green grifters.
We have forgotten that profit has been the greatest motivation known to mankind to allocate finite resources productively; that capitalism is inherently meritocratic because its survival instincts require the best talent and optimal resources; and that no society can have sustainable economic growth without profit growth that increases the capital base of the economy for future productive reinvestment.
The pursuit of profit ensures a Darwinian survival of the best economic ideas. As the infamous fictional corporate raider Gordon Gekko succinctly put it in the 1987 movie “Wall St.”:
“The point is, ladies and gentlemen, greed – for lack of a better word - is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed in all its forms, greed for life, money, love, knowledge, has marked the upward surge of mankind”.3
And it is the pursuit of profit, to paraphrase Gekko, that will save not only the Footsie but that other malfunctioning corporation called the UK.
Barry Norris
Founder Argonaut Capital
March 2024
